In this blog, we will talk about one of the most common retirement plans that you or your spouse might have – the 401(k) plan. Most people have heard of a 401(k) plan. Just in case you haven’t heard of a 401(k) plan, it is a retirement savings plan that is sponsored by an employer. It allows the employee to save and invest in some of their paycheck before federal taxes are withheld. However, taxes are paid when money from the 401(k) is withdrawn. So, how do you divide a 401(k)? Read on to find out.
How Will a 401(k) Be Divided in a Divorce
As you may have learned by now, if any of your 401(k) was earned during the marriage, it will be divided as community property. While these plans are subject to division in your divorce, it first must be decided how much of the plan is community property and how much of it is separate property.
A 401(k) can be characterized as community property or separate property. Oftentimes the plan will contain both types of property. This is because even if the plan is considered separate property (i.e. you started the plan before your marriage), the interest in the plan is likely community property (property acquired during the marriage).
If you or your spouse believe that they have a claim to the interest on the plan, this amount is determined by taking the value of the plan at the time of the marriage (separate property) and subtracting it from the value at the time of the divorce. The spouse who does not have the 401(k) plan has a claim to this interest amount.
Issues With Splitting A 401(k)
Issue #1: The Formula
One of the major issues with splitting a 401(k) in a divorce is that the formula used to determine that interest and what division should take place is not accepted by everyone. Though the formula is a widely accepted way to determine community property in a 401(k) plan, some people criticize the formula. This is because the formula does not account for inflation in shares that would be characterized as separate property. These shares would be considered community property if using this formula, which could provide inaccurate calculations in terms of community and separate property division in your divorce. Texas courts recognized this discrepancy and claimed that those looking to divide a 401(k) plan could also use other factors in determining community and separate property. This is where a lawyer will be very helpful to you. A lawyer can consider the big picture and make sure that your 401(k) is split fairly between both spouses.
Issue #2: The Property Division Spreadsheet
Dividing a 401(k) plan gets complicated if you or your spouse took out a 401(k) loan. The reason why is because representing a loan made to the 401(k) holder becomes difficult to depict on the property division spreadsheet. The 401(k) statement will list both an account balance and the loan balance. But, the balance of the 401(k) plan will not include the amount of this loan. An inexperienced attorney might deduct the loan from the current balance in the 401(k), but a plan administrator will tell you that this is not the proper approach to take. Why? Because a 401(k) loan is a loan that a person owes to themselves, not a third party. This makes it both a loan and a receivable.
The correct way to represent this loan on the property division spreadsheet is by both listing the balance of the plan and accounting for the loan. The net value of the loan itself is zero because it exists as both an asset and debt. Remembering this is important when it comes to filling out the property division spreadsheet correctly since courts will use the spreadsheet as a guide when distributing/dividing a 401(k) and other marital property.
If your divorce involves a 401(k) plan, you need to make sure that you divide it properly. This will confirm that you receive what you are entitled to and to make sure that you divide your retirement plan properly. If you’re ready to discuss your case with a lawyer today, reach out to our team.